Buy OGZPY, Sell Coal Stocks Amid Russia-China Nat. Gas Deal

by Aaron Levitt | January 10, 2014 11:10 am

It’s no secret that China is very very hungry for energy as it seeks to grow its dragon-sized economy. The country has consumed a wide variety of energy sources to fuel that hunger, the bulk of which has been good old-fashioned coal. Exports to China have surged since 2002, and the nation has become the No. 1 stop for coal stocks’ long-term strategies.

[1]Feeding this hunger has helped produce some pretty hefty gains for coal stocks over the last ten years or so. But that good fortune could be changing.

After years of pricing disagreements, political tensions and logistical issues[2], China is moving ever closer to receiving natural gas imports from its neighbor and BRIC buddy Russia. Various compromises between the two emerging market giants continue and now several insiders say that a huge deal to pipe Russian natural gas into China could be coming sooner than later.

For investors, that sets off a series of opportunities, along with a few pitfalls for the coal stocks that are already China’s energy habit.

Benefiting Coal Stocks For Years

China’s energy use has surged during the past few years as it continues its modernization programs. Overall, the main emerging market has become world’s largest energy consumer, surpassing the United States back in 2010. What’s more is that China will see its energy demand surge to 220 quadrillion BTUs by the time 2040 hits.

So far, the main energy source fueling that rising demand has been coal, through coal stocks like Cloud Peak Energy (CLD[3]). Chinese coal consumption is up a staggering 157% since 2002, and the nation now consumes more than 50% of the world’s coal stocks output. However, with China heavily drenched in smog and air pollution, Beijing has been working to add other energy sources — such as solar and wind — to its mix. Even with these advances, China is still betting heavily on fossil fuels like coal.

Which is where BRIC buddy Russia comes in.

Russia has the abundant natural gas reserves that China so desperately needs to fuel its future growth. And the Asian Dragon realized that ten years ago. Unfortunately, negotiations fell flat and China was still forced to move towards coal.

Until now.

According to both Chinese and Russian insiders, the two BRIC nations have finally agreed on terms for a massive deal that would finally get Russian gas inside China via an enormous pipeline system. The key sticking point — which worked in the coal stocks’ favor — was the price at which Russia would supply natural gas.

That single issue had derailed the negotiations for more than a decade. But now it seems that Russia/China have agreed on a price.

Overall, Russia will supply China natural gas[4] at about $10- $11 per million BTUs — after taking out several transportation calculations/fee waivers. Russia will ship this gas through an expanded 2500 mile pipeline network dubbed “The Power of Siberia” that connects several large Russian gas fields.

Aside from being a big win for Russia, the deal is also pretty big news for investors as well … unless you’re invested in the major U.S. coal stocks.

One Natural Gas Buy

The obvious winner in any sort of Chinese-Russian deal is state-backed natural gas giant Gazprom (OGZPY[5]). The company has a virtual exporting monopoly on the fossil fuel and would be the main supplier and pipeline owner in this huge project. That fact could be a game changing occurrence for OGZPY shares.

As the China deal has languished and European demand fallen, Gazprom has gone nowhere, which has been reflected in the company’s stock price. OGZPY shares only managed to gain about 2% in 2013, while other energy stocks surged on the backs of higher energy prices. Meanwhile, QGZPY is currently trading for just a price-to-earnings ratio of 2.36 and price-to-book at 0.4. That actually makes Gazprom the single cheapest energy[6] stock out there.

However, the China deal is the main catalyst that could finally propel Gazprom stock upwards. If it happens — which is becoming more likely every day — shares could finally realize their potential. If Gazprom where to trade at similar multiples to, say, Exxon (XOM[7]), the share price could double.

Two Coal Stocks To Sell

If Gazprom is the big winner, than its stands to reason that the potential big losers could be U.S. coal stocks. And the two biggest could be Arch Coal (ACI[8]) and Peabody Energy (BTU[9]).

Both have already felt the one-two punch of dwindling demand here at home coupled with rising environmental regulations. ACI stock fell nearly 38% last year, while BTU stock fell 275 in 2013. This is already on the backs of sharp declines in 2011 and 2012 for BTU and ACI stock — to tune of 71% and 81%, respectively.

However, those price drops could be just the beginning for the two coal stocks as the deal gets finalized and the countries begin piping gas.

Because ACI and BTU are the nation’s two largest coal stocks as well as two of the biggest suppliers to China, the deal could mean more losses for investors as the Asian Dragon replaces coal with Russian piped gas. ACI stock is especially vulnerable as it’s a far from easily accessible ports. BTU at least can shift some of its production in Australia towards India and other emerging Asian markets.

Investors are already beginning to worry, as even the hint of a potential deal sent shockwaves down the spines of both ACI BTU stock. Since the beginning of the year, the losses for both ACI and BTU stock have continued. China has become so much of their focus over the last two years that any in further drop demand could lights out at ACI and BTU.

For investors, playing the landmark deal is as easy as buying Gazprom and avoiding the U.S. coal stocks for now.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.